Initially published 23 April 2018
If you will remember, a few years ago there was a rush on silver and gold at the height of the current financial downturn in which the prices of both commodities to record highs. Gold alone peaked at over $1500 an ounce but has since come back down to where it is currently trading in the $1300 an ounce range. As recently as 2001 gold was $350 an ounce and in 1970 it went for slightly above $200. The price of gold is traditionally a measure of confidence in the markets and the continued high prices reflect an underlying uncertainty in and lack of confidence in the monetary system on the part of both individuals and institutional investors.
The question about a monetary collapse that I see is: what do we need to look for to determine whether a collapse is imminent or not? That is not an easy question to answer because we have to understand somewhat how the system works. Now I am not an MBA or economist by any means but I do invest and I have to admit I do pretty well. I made it my business to try and get a grasp on the economic system and the way the markets work to maximize my investment knowledge and make my investments better. Everyone that wants to discuss the likelihood of monetary collapse should get knowledgeable as well. Many people seem to say fiat money and think that settles it, but it actually does not. Fiat money may be a core issue but it is not the only issue that could lead to monetary collapse. Other issues include both sovereign and private, taxes, trust, and accountability. I would argue that trust and accountability are the two issues that should worry us the most and not debt or even fiat currency.
There are many people and websites that complain about the current financial system and the lack of anything backing the major currencies. That is a valid complaint in my opinion. As we have witnessed with QE1 & QE 2 since 2009 the Fed has the ability to artificially inflate and deflate the amount of US currency in circulation at will and the same thing has happened in the EU and with the British Pound. The US money supply has been increasing at an increasingly rapid pace since 2001 as even the Fed’s data show. Since September 2001, the US money supply as measured by the Fed has more than doubled and is almost seven times what it was in 1980. Not all that increase is because of the Fed but much of it is, especially the increase in the last decade and especially since the crash of 2008.
Given that the money supply is growing that leads us to segue into fiat currency. What is fiat currency? Investopedia defines it as “Currency that a government has declared to be legal tender, but is not backed by a physical commodity.” Simply put, fiat currency is money that is not backed by anything other than people’s trust that it is worth something. Fiat currency is actually new in the world financial scene. Prior to World War I most major currencies were backed by gold, as in for every dollar note out there the government had a dollar of gold in storage at a fixed exchange rate. That is what is meant by the Gold Standard. That actually lasted until 1914, went out the window during the inflationary war years, returned in the inter-war period and disappeared again during World War II. In 1944, the Bretton Woods monetary system was instituted in which gold still backed currency but exchange rates were more fluid. Bretton Woods went away in 1971 went President Nixon “closed the gold window” and allowed the dollar to float freely on international markets. In 1973, all major currencies were unpinned from reserve metals and modern Fiat money was born.
Ironically, the gradual rise in gold prices can be dated pretty close to the end of Bretton Woods. Fiat money is worth whatever the government and investors say it is worth, in reality it is only worth what somebody willing to take it says it is worth. I agree with the fiat money alarmists to the extent that I think the current system is built on a house of cards and could easily collapse.
Next up is debt, both sovereign and private. Any thinking person knows that the federal debt is unreal. What most people don’t grasp is the different between debt and deficit. I blame the media for that. A financial debt and a financial deficit are two different but related things. If you watch the news everybody worries about the deficit and only thinking people worry about the debt. Simple definitions are: A debt is money you owe, a deficit is money you spend more than you earn.
To illustrate: If borrow $10 bucks from you then I incurred a $10 debt to you. Now if I make $10 but spend $20 because I borrowed $10 from you then I have a $10 deficit. If I do that every month for a year I still only have a $10 per month deficit but at the end of the year I have a $120 debt. See the difference.
People get upset because the government runs a trillion dollar deficit (for illustration a trillion is written out $1,000,000,000,000), which is bad, but it is even worse when added onto the $17.6 trillion in debt we already have. What is more is that the debt figures released don’t account for the money that will be spent in the future to pay for such things as Social Security, Medicare, and other programs known as unfunded-liabilities.
In addition to the mountain of debt we hold as individuals, total household debt in the US was a little over $11 trillion at the beginning of 2013 and 30% of that was unsecured debt. As of 2011 median household debt in the US was $70,000 with 69% of households having some debt. Numbers in the EU look just about as bad.
The debt problem in the US and world is not just a debt problem of countries, it is a debt problem of people too. I blame government because governments have shown for decades that you can borrow and live how you want apparently forever. If the government can do it why can’t bill and Mary on Main Street? The good news is that the 208 crisis apparently woke some people up because household debt is trending downward, the bad news is that this trend in household debt is offset by government debt creation and spending.
Next up is accountability. This is a tough one because there is a huge regulatory system for just about every aspect of the financial system and that system is obviously a failure. The alphabet soup of regulatory agencies include, but are certainly not limited to the Federal Reserve Board, CFPB, FDIC, FINRA, SEC, OCC, CFTC, and a smorgasbord of state level agencies.
If the system worked then the housing crisis that started in 2007 would not have happened and neither would the subsequent financial crash because the sale of worthless mortgage backed securities would not have been able to occur. To add insult to injury instead of getting serious and simplifying the system to ensure such things can’t happen again Congress added more regulation on top of an already unwieldy system making it even less responsive. The average person isn’t stupid and sees this and loses faith in the system, rightly, in my opinion. Despite the number of agencies tasked with watching the system people still get away with scams, sometimes for years, just look at Enron and Bernie Madoff for examples of huge scams that affected millions. It would appear that the regulatory framework is either flat broken or so complex that cheating can go undetected for years. In any case, accountability, both in terms of law enforcement and to investors is sorely lacking.
The final issue that directly relates to the imminence of monetary collapse is trust. Trust by the average person that their investments are safe, their currency has some value, and that they are not at the mercy of forces beyond their control. That trust has been sorely tried over the past six years but it was under attack before then, the 2008 crisis just highlighted the extent to which government, central bankers, and investment professionals could not be trusted.
The government has not been a good steward of the public trust. The debt and deficit is out of control and heir appears no likelihood that it will be brought under control any time soon. What we hear from Washington is how they need to higher taxes for more spending that many people don’t want. If they cannot get taxes raised they borrow the money and then hold the country hostage to raise the debt ceiling. There are few people in DC talking about how to control spending reasonably and they get ignored, derided, or shouted down. Less than half of people polled by Gallup in September, 2013 say they trust government, in that same poll people say they trust their state and local government much more than the Feds. A Pew poll from October, 2013 has only 19% of people trusting government. That downward trend does not just date from 2009, it started almost immediately after trust peaked in the wake of the 9/11 attacks in 2001. Distrust of government is not a uniquely American phenomenon either. The Europeans don’t trust their governments either as a 2012 report from the European Commission showed.
Beyond government trust in central banks and government finance institutions is fading as well. Much of this loss of trust is self-inflicted. The Feds quantitative easing (QE) program has caused many people to mistrust the government. Then they act surprised that the wholesale printing of money makes people unhappy. The only people profiting from QE are the feds who can inflate away some portion of the debt and institutional investors who are doing the same thing. For the common man it just makes paychecks worth less for those lucky enough to still be getting a paycheck in the face of all the failed stimulus. The situation in Europe is no better as the slow motion train wreck that is the euro demonstrates. Five years on and the Eurozone still has not figured out how to stabilize itself. There is double digit unemployment in the EU and nobody seems able to reverse it. The ECB calls for austerity have apparently backfired and only made things worse for the PIIGS group of countries while the Northern countries use their economic power to do coerce them, which they should have done before ever letting them join the euro in the first place. Central bankers have shown an amazing ability to play cover their own ass while failing to do anything substantive or effective. No wonder people don’t trust central banks.
Lastly, is trust in investment professionals? Given that the roots of the 2008 crisis lie in the sale and trading of mortgage backed securities and that many of the people that bought and sold those securities came out smelling like a rose as the people holding the mortgages those securities were based on were put on the street is it any wonder that investment bankers and Wall Street finance types are not trusted? According to a Gallup poll from June, 2013 only 26% of Americans have confidence in the banking system and that is from a low of 21%. Trust is a precious commodity and once lost it is hard to regain.
All of these things combine to paint a picture of a monetary system that is serious trouble. Not only is debt out of control but people don’t trust either their government or their bank to do right by them. The world economy is somewhat fragile and a combination of just a few shocks could cause the failure of the whole system. The thing that keeps it limping along is the interconnectedness of the world economy. It would take an event that affects multiple regions of the world to collapse it. That could happen though. The only thing that could cause it to collapse entirely is something so big that it has so many knock-on effects that it becomes uncontrollable. An example of something with multiple knock-on effects that could collapse the world economy that I can think of are the collapse of the Euro, a true US default on the public debt, or perhaps if China were to let the Renminbi float.
Now, what do I see the likelihood of a monetary collapse being? Here are my cloudy crystal ball predictions.
- Short-term-the next 5 years – roughly 30% chance of a collapse occurring
- Medium-term-in 5-15 years – roughly 50% chance of a collapse occurring because of the time bomb of entitlement spending effect on the national debt
- Long-term-more than 15 years from now – with structural reform 15% chance, absent any significant reform 60% chance